Strategic Cross-Subsidies and Vertical Integration in Opening Telecommunications Markets

Abstract

This paper analyzes the strategic role of cross-subsidies under vertical integration. We consider an incumbent firm which operates in a regulated market (switched telecommunications service) and a competitive market (unswitched service). Fitting cost data generated with an engineering cost proxy model to smooth functional forms, we first assess the extent of cross-subsidies due to allocation of common costs and managerial effort. We then focus on the cost incentives of the regulatory scheme in the regulated segment and identify situations where the incumbent may blockade entry in the competitive segment.